Growth, Reforms, and Investments: The Road Ahead for Indian Stock Market.

The suspense surrounding the formation of the government, whether it will be led by the ruling BJP or the opposition Congress alliance, will be resolved on June 4, 2024, when the vote count is completed. While media speculation is rampant about the ruling party retaining power, we will refrain from conjecture and focus solely on the stock market implications.

Historically, economic reforms have continued irrespective of the ruling party, leading to sustained growth, which is favorable for the stock market. Both the BJP and Congress have pledged growth and infrastructure investment in their manifestos, indicating policy continuity.

Following the government formation, attention will shift to the next budget, anticipated in late July 2024. Under the NDA regime in FY20, the fiscal deficit surged to 9.17% due to increased post-COVID spending but has since been improving. We expect the fiscal deficit to fall below 5% in the medium term. Additionally, a significant transfer of Rs. 2 Lakh Crores from the RBI to the government will bolster government finances.

The Nifty Midcap 100 index has outperformed large caps, rising approximately 66% since the beginning of 2023, while the Nifty index has rallied 25% in the same period. The midcap index trades at 29.3x forward earnings, compared to 19.6x for the Nifty index.

Sectors traditionally favored by foreign portfolio investors, such as Private Banking and IT services, have underperformed but are expected to reverse this trend soon. Private sector banks offer medium-term value as valuations normalize. We anticipate robust foreign portfolio inflows due to limited global growth opportunities.

In the banking sector, PSU banks hold about 61% of deposits, supported by central government reforms like the Insolvency and Bankruptcy Act of 2016. Loan growth is expected to slow as the RBI pressures banks to manage retail loan growth and loan-to-deposit ratios.

Domestic fund managers are concerned about potential changes to capital gains tax in the upcoming budget, speculating on higher tax rates or extended holding periods for long-term capital gains. This aims to curb excessive speculative activity in the options segment, which saw turnover rise from Rs. 123 trillion in FY20 to about Rs. 921 trillion in FY24. We believe major changes to the capital gains tax structure are unlikely, though measures to curb speculation may be introduced.

The government is likely to offer more incentives for the affordable housing segment, boosting advances and profitability for players in this space. Continued investment in infrastructure will drive GDP growth, and defense firms are expected to benefit from increased government orders and improved efficiency.

Efforts to attract global EV manufacturers like Tesla, which is diversifying operations from China, could enhance the EV market in India, given the rising demand for electric vehicles.

The mid and small-cap segments have become expensive, but stock-specific opportunities remain. Investors should seek reasonably valued stocks in these segments. With the Indian economy poised to grow at 6%-7% in the medium term, the market is likely to trade at premium valuations, attracting global investors. The economy's growth potential should encourage investors to buy stocks, using market corrections as opportunities to acquire good stocks at reasonable valuations.

Happy Investing!